How is bonus income taxed?

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A bonus is payment to an employee over and above his normal compensation as a reward for a job well done. Some companies base this on personal performance and others on corporate performance in order to reward teamwork. In some workplaces, most of an employee's annual income comes from bonuses. This is common in the financial sector and in sales-oriented jobs.

There is no set rule that universally applies for how bonus income is taxed, and it varies with each individual's circumstances. Employers usually withhold taxes on bonus income just as they do with salaries, and in doing so follow specific IRS guidelines.

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Tax Withholding

The IRS has rules that employers must follow when withholding taxes from bonus income. How much is withheld and what system is used to calculate this amount depends primarily on how much bonus income is involved. If the bonus is in excess of £0.6 million, then employers are required to withhold 35 per cent regardless of other factors. However, if the bonus income is less than £0.6 million, employers have a number of options when it comes to withholding. This usually depends on your tax bracket, the number of exemptions you claim on your W-4 form and if the bonus is paid with regular wages within a pay period or treated separately as bonus income.

The IRS has detailed instructions on how these should be calculated that are outlined in IRS Publication 15 (see Resources). However, many employers just withhold 25 per cent of your bonus income to be on the safe side. Find out from your employer what system is used in withholding. If your employer uses the specific approach, you can use a good online calculator to estimate how much will be withheld from your bonus check (see Resources).

What You Pay

The IRS treats bonus income as supplemental income. The amount of tax you eventually pay on the bonus income when you file your tax return depends largely on your personal circumstances. Your entire income, as well as deductions you claim, are taken into consideration at this point. If you are using a tax-filing software, you just need to answer some questions and it automatically computes how much, if any, tax you owe.

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